FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 0-23110
DIGITAL LINK CORPORATION
(Exact name of registrant as specified in its charter)
California 77-0067742
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
217 Humboldt Court, Sunnyvale, California 94089
(Address of principal executive offices, including zip code)
(408) 745-6200
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
The number of shares outstanding of the registrant's common stock at
May 14, 1997 was 9,175,839.
DIGITAL LINK CORPORATION
INDEX TO FORM 10-Q
Page
PART I - FINANCIAL INFORMATION:
ITEM 1 - Financial Statements
Consolidated Balance Sheets as of March 31, 1997
and December 31, 1996 3
Consolidated Statements of Income for the three months
ended March 31, 1997 and March 31, 1996 4
Consolidated Statements of Cash Flows for the three months
ended March 31, 1997 and March 31, 1996 5
Notes to Consolidated Financial Statements 6
ITEM 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
ITEM 3 - Quantitative and Qualitative Disclosures About
Market Risks 15
PART II - OTHER INFORMATION
ITEM 1 - Legal Proceedings 16
ITEM 2 - Changes in Securities 16
ITEM 3 - Defaults Upon Senior Securities 16
ITEM 4 - Submission of Matters to a Vote of Security Holders 16
ITEM 5 - Other Information 16
ITEM 6 - Exhibits and Reports on Form 8-K 17
SIGNATURE(S) 18
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
DIGITAL LINK CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share amounts)
March 31, Dec. 31,
1997 1996
(unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 5,724 $ 2,043
Short-term marketable securities 22,510 19,585
Accounts receivable, less allowance
for doubtful accounts 6,301 6,490
of $527 at 3/31/97 and $465 at 12/31/96
Inventories, net 5,978 5,920
Prepaids and other current assets 1,346 1,131
Deferred income taxes 2,285 2,285
Total current assets 44,144 37,454
Property and equipment at cost, net 2,309 2,147
Long-term marketable securities 16,069 22,420
Other assets 1,013 712
TOTAL ASSETS $ 63,535 $ 62,733
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 2,973 $ 1,947
Accrued payroll expense 1,809 1,648
Other accrued expenses 3,527 3,795
Income taxes payable 2,016 1,541
Total current liabilities 10,325 8,931
SHAREHOLDERS' EQUITY:
Preferred stock, no par value:
Authorized: 5,000,000 shares;
Issued and outstanding: None
Common stock, no par value:
Authorized: 25,000,000 shares;
Issued and outstanding: 9,142,931 shares
at 3/31/97 and 9,218,150 shares at 12/31/96 30,658 30,913
Unrealized gain on marketable securities 141 257
Retained earnings 22,411 22,632
Total shareholders' equity 53,210 53,802
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 63,535 $ 62,733
The accompanying notes are an integral part of these consolidated financial
statements.
DIGITAL LINK CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
FOR THE THREE MONTHS ENDED
MARCH 31, 1997 AND 1996
(Amounts in thousands, except per share amounts)
Three Months Ended
March 31,
1997 1996
REVENUES:
Net sales $16,038 $10,203
Cost of sales 6,816 4,366
Gross profit 9,222 5,837
EXPENSES:
Research and development 3,032 2,050
Selling, general and administrative 4,916 3,584
Total operating expenses 7,948 5,634
Operating income 1,274 203
Other income 641 633
Income before provision for income taxes 1,915 836
Provision for income taxes 583 280
NET INCOME $ 1,332 $ 556
NET INCOME PER SHARE $ 0.14 $ 0.06
Shares used in computing per share amounts 9,577 9,352
The accompanying notes are an integral part of these consolidated financial
statements.
DIGITAL LINK CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 1997 AND 1996
(Amounts in thousands)
Three Months Ended
March 31,
1997 1996
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,332 $ 556
Adjustments to reconcile net income to net cash flows
provided by operating activities:
Depreciation and amortization 323 315
Provision for doubtful accounts 62 20
Provision for excess and obsolete inventories 58 41
Changes in assets and liabilities:
Accounts receivable 127 1,195
Inventories (116) 69
Prepaid and other assets (516) (28)
Accounts payable 1,026 252
Accrued payroll and other accrued expenses (107) (336)
Income taxes payable 475 (95)
Net cash flows provided by operating activities 2,664 1,989
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities (1,030) (13,753)
Maturities of marketable securities 4,340 18,496
Acquisition of property and equipment (485) (426)
Net cash flows provided by investing activities 2,825 4,317
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from exercise of stock options 138 55
Repurchase of common stock (1,946) 0
Net cash flows provided by (used in)
financing activities (1,808) 55
Net increase in cash and cash equivalents 3,681 6,361
Cash and cash equivalents at beginning of period 2,043 2,639
Cash and cash equivalents at end of period $ 5,724 $ 9,000
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for income taxes $ 43 $ 379
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING
ACTIVITIES:
Unrealized gain (loss) on securities carried
at market $ (116) $ 277
The accompanying notes are an integral part of these consolidated financial
statements.
DIGITAL LINK CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared by
the Company without audit in accordance with generally accepted accounting
principles for interim financial information and pursuant to rules and
regulations of the Securities and Exchange Commission. In the opinion of
management, all adjustments (consisting of only normal recurring adjustments)
considered necessary for a fair representation have been included. These
financial statements should be read in conjunction with the Company's
consolidated financial statements and notes thereto contained in the
Company's Annual Report on Form 10-K, which was filed with the Securities
and Exchange Commission on March 28, 1997.
The year-end balance sheet at December 31, 1996 was derived from audited
financial statements, but does not include all disclosures required by
generally accepted accounting principles.
Operating results for the three months ended March 31, 1997 may not
necessarily be indicative of the results to be expected for any other
interim period or for the full year.
2. COMPUTATION OF NET INCOME PER SHARE
Net income per share is computed using the weighted average number of
common and dilutive common equivalent shares outstanding during the period.
Dilutive common equivalent shares consist of stock options using the
treasury stock method for all periods presented.
3. INVENTORIES
Inventories are valued at the lower of cost (determined using the first-in,
first-out method) or market. Inventories consisted of (in thousands):
March 31, 1997 December 31, 1996
(Unaudited)
Raw materials $ 2,392 $ 2,255
Work-in-process 1,933 2,301
Finished goods 1,653 1,364
$ 5,978 $ 5,920
4. CONTINGENCY
Certain third parties have expressed their belief that certain of the
Company's products may infringe patents held by them and have suggested
that the Company acquire licenses to such patents. The Company believes
that licenses, to the extent required, will be available; however, no
assurance can be given that the terms of any offered licenses would be
favorable to the Company. Management, after review and consultation with
counsel, believes that the ultimate resolution of these allegations is
uncertain and there can be no assurance that these assertions will be
resolved without costly litigation or in a manner that is not adverse to
the Company. While the Company has accrued certain amounts for these
matters in prior years, it is currently unable to estimate the possible
loss or range of loss regarding these matters. Therefore, the ultimate
resolution of these matters could result in payments in excess of the
amounts accrued in the accompanying financial statements and require
royalty payments in the future which could adversely impact gross margins.
In April 1996, a first amended class action complaint was filed against the
Company and certain of its officers and directors in the Santa Clara Superior
Court of the State of California, alleging violations of the California
Corporations Code and California Civil Code. In October 1996, a similar
parallel lawsuit against the Company and the same individuals was filed in
the United States District Court for the Northern District of California
alleging violations of the federal securities laws. The class period in both
of these lawsuits runs from September 12, 1994 through December 29, 1995,
and both complaints allege that the defendants concealed and/or
misrepresented material adverse information about the Company and that the
individual defendants sold shares of the Company's stock based upon material
nonpublic information. The complaints seek unspecified monetary damages.
On May 8, 1997, the Superior Court dismissed portions of plaintiff's first
amended state court complaint without leave to amend. The Superior Court
also sustained the demurrer of certain individual defendants to the other
portions of plaintiff's complaint, while it overruled a similar demurrer
by the Company and the other individual defendants. The Court has granted
plaintiff leave to file another amended complaint. The Company has also
moved to dismiss the federal complaint. The Court heard oral argument on
defendants' motion on April 18, 1997 and took the motion under submission.
The Company believes that both actions are without merit and intends to
defend both actions vigorously. However, ligitation is subject to inherent
uncertainties and, thus, there can be no assurance that these lawsuits will
be resolved favorably to the Company or that they will not have a material
adverse affect on the Company's financial condition and results of
operations. Accordingly, no provision for any liability that may result
upon adjudication has been made on the accompanying financial statements.
5. RECENT ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement No. 128, "Earnings Per Share" (SFAS 128), and Statement No. 129,
"Disclosure of Information About Capital Structure" (SFAS 129). These
Statements will be effective for the Company's fiscal year 1997. SFAS 128
requires a revised presentation and calculation of earnings per share (EPS)
and that prior periods be restated to conform to that revised presentation
and calculation. SFAS 129 requires disclosure about the entity's capital
structure and contains no change in disclosure requirements for entities
that were subject to the previously existing requirements. Early
adoption of these Statements is not permitted and the adoption of SFAS 129
will not have a material affect on the Company's financial position and
results of operations. The impact of the adoption of SFAS 128 on the
financial statements of the Company has not yet been determined.
DIGITAL LINK CORPORATION
ITEM 2. Management's Discussion And Analysis of Financial Condition and
Results of Operations
RESULTS OF OPERATIONS
Except for the historical statements contained herein, this Form 10-Q
contains forward looking statements within the meaning of Section 21E of
the Securities Exchange Act of 1934, as amended (the "Exchange Act").
These forward looking statements involve a number of risks, known and
unknown, and uncertainties, such as the loss of, or difference in actual
from anticipated levels of purchases from, the Company's major customers,
the impact of competitive products and pricing and other risks which are
described throughout the Company's reports filed with the Securities and
Exchange Commission, including its Form 10-K for the year ended December 31,
1996, and within "Management's Discussion and Analysis of Financial
Condition and Results of Operations," including under the title "Other
Factors That May Affect Future Operating Results." The actual results
that Digital Link Corporation (the "Company" or "Digital Link") achieves
may differ materially from any forward looking statements due to such risks
and uncertainties.
Readers are urged to carefully review and consider the various disclosures
made by the Company in this report and in the Company's reports filed with
the Securities and Exchange Commission that attempt to advise interested
parties of the risks and factors that may affect the Company's business.
Due to all the foregoing factors, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as an indication of future performance. Similarly,
past performances are not necessarily indicative of future results. It is
likely that, in some future quarters, the Company's operating results will
be below the expectations of stock market analysts and investors. In such
event, the price of the Company's Common Stock would likely be materially
adversely affected. Consequently, the purchase or holding of the Company's
Common Stock involves an extremely high degree of risk.
Net Sales
Net sales for the first quarter of 1997 increased 57% to $16,038,000 from
$10,203,000 for the same period of the prior year. This increase in net
sales was primarily attributable to an increase in unit sales of both
broadband (i.e., transmission rates in excess of T1/E1) products and
narrowband (i.e., transmission rates up to T1/E1) products primarily
within the Encore product family. These increases were offset in part by
decreased average selling prices on certain narrowband and broadband
products as a result of price reductions made throughout 1996. The Company
does not believe that the percentage change in net sales in the first
quarter of 1997 as compared to the same period of the prior year is
necessarily indicative of the percentage change in net sales to be
expected for the entire fiscal year.
Narrowband sales in absolute dollars increased by 21% and decreased to 56%
of net sales in the first quarter of 1997 as compared to 72% in the first
quarter of 1996. Broadband sales increased in absolute dollars by 151% and
increased as a percentage of net sales to 44% in the first quarter of 1997
as compared to 28% in the first quarter of 1996. The changes in narrowband
sales and broadband sales as a percentage of net sales were primarily due
to higher sales of broadband products to certain domestic carrier customers.
International sales (including sales in Canada) represented 14% of net
sales in the first quarter of 1997 as compared to 12% in the first quarter
of fiscal 1996. This increase was primarily due to an increase in unit
sales of the Company's narrowband and broadband products. International
sales are subject to inherent risks, including difficulties in homologating
products in other countries, difficulties in staffing and managing foreign
operations, greater difficulty in accounts receivable collection, unexpected
changes in regulatory requirements and tariffs, and potentially adverse tax
consequences, which may in the future contribute to fluctuations in the
Company's business and operating results.
Gross Profit
Gross profit increased 58% in the first quarter of 1997 to $9,222,000 from
$5,837,000 for the same period of the prior year. Gross margin increased
slightly to 57.5% of net sales in the first quarter of 1997 as compared to
57.2% in the first quarter of 1996. This increase in gross margin is a
result of a shift to broadband sales which have higher gross margins than
narrowband products, offset by the above mentioned price reductions. Gross
margins may vary significantly from quarter to quarter depending on many
factors including competitive pricing pressures and changes in the mix of
products sold. A significant portion of the Company's business is very
price competitive, which has in the past and will in the future require the
Company to lower its prices, resulting in fluctuations in the Company's
business and operating results. The Company anticipates that this increased
pricing pressure will continue during 1997. In addition, the mix of products
sold may continue to change to include a higher percentage of narrowband
products which generally have lower gross margins and would therefore
adversely affect the Company's overall gross margins.
Research and Development
The primary types of expenses included in research and development ("R&D")
expenses are personnel, consulting, prototype materials and professional
services. R&D expenses increased 48% to $3,032,000 in the first quarter of
1997 from $2,050,000 in the first quarter of 1996. This increase is
primarily due to higher consulting fees related to the Company's DL7100
product (formerly known as W/ATM GateWay) and to a lesser extent material
costs for prototype products. As a percentage of net sales, R&D expenses
were 18.9% in the first quarter of 1997 as compared to 20.1% in the first
quarter of 1996. This decrease as a percentage of net sales was
primarily the result of operating efficiencies from higher net sales in
the first quarter of 1997. The Company anticipates that its R&D expenses
will continue to increase in absolute dollars and as a percentage of sales
may remain relatively flat. However, actual results could vary from the
foregoing forward looking statement due to, among other factors set forth
or referenced in "Other Factors That May Affect Future Operating Reuslts,"
below, the Company's ability to accelerate or defer operating expenses,
achieve revenue levels during such periods and hire new personnel.
All of the Company's R&D expenditures to date have been expensed as incurred.
In the future, the Company may be required to capitalize a portion of its
software development costs pursuant to Statement of Financial Accounting
Standards No. 86, "Accounting for Costs of Computer Software to be Sold,
Leased or Otherwise Marketed."
Selling, General and Administrative
The primary types of expenses included in selling, general and
administrative (SG&A) expenses are personnel, advertising, other
promotional, and travel and entertainment. SG&A expenses increased 37%
in the first quarter of 1997 to $4,916,000 from $3,584,000 for the same
period of the prior year. The increase in absolute dollars was primarily
the result of higher personnel-related expenses, primarily within the sales
and marketing organization. As a percentage of net sales, SG&A expenses
decreased to 30.7% in the first quarter of fiscal 1997 as compared to 35.1%
in the first quarter of fiscal 1996. The decrease as a percentage of net
sales was primarily the result of operating efficiencies from higher net
sales in the first quarter of 1997.
The Company has in the past hired more of its SG&A personnel and incurred
increased expenses related to trade shows and other promotional activities
during the first half of the year. Accordingly, SG&A expenses as a
percentage of net sales are generally higher during the first half of the
year. However, any decrease in such expenses as a percentage of net sales
in the second half of the year is subject to, among other factors set forth
or referenced in "Net Sales" above and "Other Factors That May Affect
Future Operating Results" below, the Company's ability to accelerate or defer
operating expenses and achieve revenue levels during the periods.
Other Income
Other income includes primarily interest income and purchase discounts.
Other income increased 1% in the first quarter of 1997 to $641,000 from
$633,000 for the same period of the prior year. This increase was
primarily due to higher interest income due to higher cash balances.
Provision for Income Taxes
The Company's effective tax rate decreased to 30.4% for the first quarter
of 1997 compared to 33.5% for the first quarter of 1996. This decrease is
due primarily to an increase in R&D credit.
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of $33.8 million and cash, cash equivalents
and marketable securities of $44.3 million at March 31, 1997. Net cash
provided by operating activities was $2.7 million for the first three
months of 1997, primarily as a result of a net income before depreciation
and amortization and an increase in accounts payable offset to some extent
by an increase in prepaid and other assets. This compares to net cash
provided by operating activities of $2.0 million for the first three months
of 1996, primarily as a result of a decrease in accounts receivable and net
income before depreciation and amortization offset to some extent by a
decrease in accrued payroll and other accrued expenses. Cash provided by
investing activities during the first three months of 1997 was primarily
from the maturity of marketable securities of $4.3 million offset by
additional purchases of $1.0 million. Cash provided by investing activities
during the first three months of 1996 was primarily from the maturity of
marketable securities of $18.5 million offset by additional purchases of $13.8
million. Leasehold improvements and capital equipment additions were
$485,000 in the first quarter of 1997 as compared to $426,000 in the first
quarter of 1996.
In October 1996, the Company approved the repurchase of up to 500,000 shares
of common stock for cash from time-to-time at market prices and as market
and business conditions warrant, in open market, negotiated or block
transactions. Net cash used in financing activities was $1.8 million in
the first three months of 1997, primarily from the repurchase of common
stock. Net cash provided by financing activities was $55,000 in the first
quarter of 1996 from the exercise of stock options. During February and
March 1997, the Company repurchased on the open market a total of 117,000
shares of common stock at a price ranging from $15.00 to $17.88 a share.
This stock has subsequently been retired.
The Company believes that existing cash and cash flows from operations will
be sufficient to meet its anticipated cash requirements for working capital
and capital expenditures for at least the next 12 months.
OTHER FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
In addition to the factors set forth above in the "Management's Discussion
and Analysis of Financial Conditions and Results of Operations," there
are a number of other factors that may affect the Company's future operating
results.
A significant portion of the Company's business is derived from substantial
orders placed by large end users and telephone companies, and the timing of
such orders, including the completion of the build out of carrier and ISP
infrastructures, could cause material fluctuations in the Company's business
and operating results. For example, in the fourth quarter of 1995, the
Company had lower operating results than expected due in part to a weaker
than expected demand from certain domestic carrier customers, as well as
certain other factors. Other factors that may cause fluctuations in the
Company's operating results include the gain or loss of significant
customers, seasonal capital spending patterns of large domestic customers,
changes in sales volumes through the Company's distribution channels,
changes in product mix sold toward narrowband products that yield lower
gross margins, the timing of new product announcements and introductions
by the Company and its competitors, market acceptance of new or enhanced
versions of the Company's products, availability and cost of components
from the Company's suppliers and economic conditions generally or in
various geographic areas. In addition, the Company's expense levels are
based, in part, on its expectations of future revenue. The Company
typically operates with limited order backlog, and a substantial majority
of its revenues in each quarter result from orders booked in that quarter.
If revenue levels are below expectations, the Company may be unable to
adjust spending in a timely manner, which would adversely affect operating
results.
The Company believes that its future success will depend in large part upon
the continued contributions of members of the Company's senior management
and other key personnel, and upon its ability to attract and retain highly
skilled managerial, engineering, sales, marketing and operations personnel,
the competition for whom is intense. Certain of the Company's senior
management have only recently joined the Company. For example, in September
1996, Alan Fraser joined the Company as President and Chief Executive
Officer, replacing Vinita Gupta, who remains as Chairperson of the Board of
Directors, in February 1997, Steve Tabaska joined the Company as Chief
Technical Officer and Vice President, Engineering and in April 1997, John
Eddon joined the Company as Vice President and General Manager,
International. There can be no assurance that the Company will be
successful in attracting and retaining skilled personnel to hold important
management positions or will be able to successfully integrate any new
management personnel.
The Company is currently developing and may in the future develop products
with which the Company has only limited experience and/or that are targeted
at emerging market segments, including the Company's DL7100 product
(formerly known as W/ATM GateWay). The Company has experienced delays in
the development of the DL7100 product, in part related to technical problems
which required some software to be redesigned. This product was shipped to
a customer for evaluation in February 1997 and to two additional customers
in April 1997. Given its complexity, there can be no assurance that this
product will not encounter further technical or other difficulties which
could significantly delay its deployment or acceptance or could result in the
termination of the development program for this product. If this product
becomes available, there can be no assurance that products currently
available or under development by competitors would not directly compete
with the DL7100 product, that the DL7100 will meet the needs of emerging
ATM market or that markets for the DL7100 will continue to develop, any
of which would have a material adverse affect on the Company's business
and operating results.
The market for the Company's products is highly competitive. The Company
expects competition to increase in the future from existing competitors and
from other companies that may enter the Company's existing or future markets.
In addition, the Company faces competition from internetworking suppliers,
such as routers, and telephone equipment, such as switches, which are
including a direct WAN interface in their products that could reduce demand
for the Company's products which would have a material adverse affect on the
Company's business and operating results. As discussed above, increased
competition has also placed increasing pressures on the pricing of the
Company's products, which has resulted in lower operating results. The
Company anticipates that this increased pricing pressure will continue
during 1997.
In April 1996, a first amended class action complaint was filed against the
Company and certain of its officers and directors in the Santa Clara
Superior Court of the State of California, alleging violations of the
California Corporations Code and California Civil Code. In October 1996,
a similar parallel lawsuit against the Company and the same individuals was
filed in the United States District Court for the Northern District of
California alleging violations of the federal securities laws. The class
period in both of these lawsuits runs from September 12, 1994 through
December 29, 1995, and both complaints allege that the defendants
concealed and/or misrepresented material adverse information about the
Company and that the individual defendants sold shares of the Company's
stock based upon material nonpublic information. The complaints seek
unspecified monetary damages. On May 8, 1997, the Superior Court dismissed
portions of plaintiff's first amended state court complaint without leave
to amend. The Superior Court also sustained the demurrer of certain
individual defendants to the other portions of plaintiff's complaint,
while it overruled a similar demurrer by the Company and the other
individual defendants. The Court has granted plaintiff leave to file
another amended complaint. The Company has also moved to dismiss the
federal complaint. The Court heard oral argument on defendants' motion
on April 18, 1997 and took the motion under submission. The Company
believes that both actions are without merit and intends to defend both
actions vigorously. However, litigation is subject to inherent
uncertainties and, thus, there can be no assurance that these lawsuits
will be resolved favorably to the Company or that they will not have a
material adverse affect on the Company's financial condition and results
of operations. Accordingly, no provision for any liability that may result
upon adjudication has been made on the accompanying financial statements.
The telecommunications industry is characterized by the existence of a
large number of patents and frequent litigation based on allegations of
patent infringement. For example, a third party has on several occasions
expressed its belief that certain of the Company's products, including its
CSU/DSUs, may infringe upon patents held by it and has suggested on such
occasions that the Company acquire a license to such patents. The Company
believes that a license, to the extent required, will be available; however,
no assurance can be given that the terms of any offered license would be
favorable to the Company. Should a license be unavailable, the Company
could be required to discontinue the sale of or to redesign certain of its
products. In addition, Larscom, a competitor of the Company, has continued
to express its belief that the Company's inverse multiplexer products may
infringe a patent jointly owned by Larscom and a third party and has
suggested that the Company acquire a license to the patent. See Note 4 of
Notes to Consolidated Financial Statements in Part 1, Item 1 of this Form
10-Q. There can be no assurance that the other third parties will not
assert infringement claims against the Company in the future, that any
such claims will not result in costly litigation or that the Company
will prevail in any such litigation or be able to license any valid and
infringed patents from third parties on commercially reasonable terms.
The risks outlined herein are difficult for the Company to forecast, and
these or other factors can materially affect the Company's operating results
and stock price for one quarter or a series of quarters. Further, in recent
years the stock market has experienced extreme price and volume fluctuations
that have particularly affected the market prices of securities of many
high technology companies, for reasons frequently unrelated to the operating
performance of the specific companies. These fluctuations, as well as
general economic, political and market conditions, may materially adversely
affect the market price of the Company's common stock.
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement No. 128, "Earnings Per Share" (SFAS 128), and Statement No. 129,
"Disclosure of Information About Capital Structure" (SFAS 129). These
Statements will be effective for the Company's fiscal year 1997. SFAS 128
requires a revised presentation and calculation of earnings per share (EPS)
and that prior periods be restated to conform to that revised presentation
and calculation. SFAS 129 requires disclosure about the entity's captial
structure and contains no change in disclosure requirements for entities
that were subject to the previously existing requirements. Early
adoption of these Statements is not permitted and the adoption of
SFAS 129 will not have a material affect on the Company's financial
position and results of operations. The impact of the adoption of SFAS
128 on the financial statements of the Company has not yet been
determined.
ITEM 3. Quantitative and Qualitative Disclosure About Market Risk
Not Applicable.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In April 1996, a first amended class action complaint was filed against the
Company and certain of its officers and directors in the Santa Clara
Superior Court of the State of California, alleging violations of the
California Corporations Code and California Civil Code. In October 1996, a
similar parallel lawsuit against the Company and the same individuals was
filed in the United States District Court for the Northern District of
California alleging violations of the federal securities laws. The class
period in both of these lawsuits runs from September 12, 1994 through
December 29, 1995, and both complaints allege that the defendants
concealed and/or misrepresented material adverse information about the
Company and that the individual defendants sold shares of the Company's
stock based upon material nonpublic information. The complaints seek
unspecified monetary damages. On May 8, 1997, the Superior Court
dismissed portions of plaintiff's first amended state court complaint
without leave to amend. The Superior Court also sustained the demurrer
of certain individual defendants to the other portions of plaintiff's
complaint, while it overruled a similar demurrer by the Company and the
other individual defendants. The Court has granted plaintiff leave to
file another amended complaint. The Company has also moved to dismiss
the federal complaint. The Court heard oral argument on defendants'
motion on April 18, 1997 and took the motion under submission. The
Company believes that both actions are without merit and intends to
defend both actions vigorously. However, litigation is subject to
inherent uncertainties and, thus, there can be no assurance that
these lawsuits will be resolved favorably to the Company or that they
will not have a material adverse affect on the Company's financial
condition and results of operations.
ITEM 2. CHANGES IN SECURITIES
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
11.01 Statement of Computation of Net Income Per Share.
27.01 Financial Data Schedule
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the quarter ended
March 31, 1997.
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
DIGITAL LINK CORPORATION
Date: May 15, 1997 /s/ Alan I. Fraser
Alan I. Fraser
Chief Executive Officer
Date: May 15, 1997 /s/ Stanley E. Kazmierczak
Stanley E. Kazmierczak
Chief Financial Officer
EXHIBIT INDEX
Exhibits Page
11.01 Statement of Computation of Net Income Per Share. 20
27.01 Financial Data Schedule 21